Low Interest Rates Hurt Some Developers

LOS ANGELES—Developing affordable low-income housing is a challenge in any market, but the current low-interest rate environment is increasing pricing and competition for these developers, making it nearly impossible to move forward on much-needed affordable projects. Ofer Elitzur, a partner at Cox, Castle & Nicholson, talks exclusively to GlobeSt.com about the high barriers to entry for these developers and how the factors in this economic cycle are exacerbating the challenges of affordable housing. It wasn't all bad news. There are new programs and increasing subsidies for affordable developers who know how to maneuver through the system. Here, Elitzur breaks down the process of developing affordable housing—and points out the problem areas.

GlobeSt.com: What are the challenges hindering the process of developing affordable housing?

Ofer Elitzur: There are a couple of basic economic issues with the production of affordable housing that are always in place. The basic obstacles to building low-income restrictive rental housing is the cost, and that is the risk that you take when you develop an apartment building of any kind. In an affordable building you are voluntarily capping your rents and therefore capping your income. For a developer, the only reason to do that is incentives that make the deal doable. The main ones are tax credits, tax-exempt bond financing, rental assistance from HUD and the New Generation Fund that was recently re-upped in Los Angeles. A developer will really only take on an affordable housing project if they can make enough of those subsidies to make the deal worthwhile.

GlobeSt.com: Are there any new challenges that are specific to this economic cycle?

Elitzur: Yes, there are some issues in the current economic market, and that is that we are in a very low interest rate environment and there is tons of investment money, both foreign and domestic, flooding into California real estate. All of that money is chasing the same deals, the same available real estate inventory. So, an affordable developer that is competing with REITs and off-shore funds who are willing to accept low rates of return for the security that is California real estate is seeing higher prices and competition from market-rate developers. That is a current market issue that is a product of today's economic circumstance, and it is a challenge for affordable developers.

GlobeSt.com: Are affordable developers held to the same regulatory standards as a market-rate developer?

Elitzur: There are some benefits that an affordable developer gets that a market-rate developer doesn't get. Most notably, there is an exemption from property tax for a qualified low-income apartment building. That is one of the main form of subsidy for affordable developers, but that is really one of the only subsidies. For example, it isn't like an affordable developer gets any cheaper CEQA process. Environmental approvals for an affordable building are exactly the same as anyone else. Other examples of subsidies have perils, too. Developers might get density bonuses, but those bonuses often trigger prevailing wage requirements where you have to pay union set wages. So, even when there are subsidies, there are complications that go with them. It is a complicated business.

GlobeSt.com: Should there be more subsidies available to affordable developers, or, if not subsidies, expedited processes? What is your opinion?

Elitzur: It really depends on what goals we are trying to achieve in California. It is easy to bemoan the lack of affordable housing and throw your hands up and say, 'we really need developers to build more affordable housing,' but if at the same time you say, 'well, they really need to go through the same stringent CEQA review process as anyone else,' then those two work at counterpoint. I am not saying that the CEQA process in California is wrong. Certainly it has political and social value that the California legislature and the voters have found important, but you can't say that we are going to implement all of these costs because we value the protections that these cost provide and at the same time ask developers to build more affordable housing. You are seeing some early stages of engagement of professional organizations and housing development governmental bodies to identify and organize how to get more money into affordable housing and how to bring the cost constraints down. There is a movement to wrap hands around that.

GlobeSt.com: Is it impossible for a private developer to create a business plan that makes affordable housing profitable, to create a win-win situation?

Elitzur: In certain markets, there may be, but in expensive-to-develop markets like Los Angeles, it is pretty far fetched to be able to build restricted low-income housing. The issue is that the market rents that you are going to get in most core areas of L.A. are going to be out of reach for working families. We don't generate enough volume of housing in California to keep prices low by having sufficient supply. If we are going to have lower supply, then prices are naturally going to go up. In other markets that have more of a supply, it is possible to build non-restricted housing and turn a profit with a private developer. But, costs and rents are lower there. For better or for worse, in core areas of California, that is not the economic reality.

GlobeSt.com: With programs like the New Generation Fund, do you think this issue is getting better or that it is going to improve?

Elitzur: There are more sources that are popping up, and voter approved sources as well in California. For example, there was a bond measure, Prop 1C, that funded hundreds of millions of dollars in bond funds for affordable housing. Stuff like that is fantastic. The New Generation Fund isn't a huge source, but it is very important. There are things like these funds that make affordable housing doable. Is it getting easier? I would say no. It is still complicated, and for the average developer, it is hard to find out about this alphabet soup of subsidies. You have to be highly knowledgeable to pull together all of these resources. There are high barriers to entry for affordable developers to put together deals with all of these sources.